It’s a great time to be a seller of commercial real estate (CRE). As all the sectors (retail, office, industrial, and multifamily) continue to improve, investors have an increasingly positive outlook for the future.
With few income-producing properties available for sale in our market, and continued historically low interest rates, the regional demand for commercial real estate investment properties continues to build. In addition, there’s an enormous amount of institutional capital that’s been earmarked for CRE.
Finally, capitalization rates, the ratio of net operating income to capital cost, are by traditional standards in most markets relatively low, which reduces investment risk. Add to this the fact that the IRS permits 1031 exchanges (a means of swapping properties among multiple parties which greatly expands flexibility and can defer taxes) and conditions overall become extraordinary.
So what steps should would-be sellers be taking to maximize their property’s sales value? As it turns out, there are many. But the trouble is that if sellers wait until just now to take such steps, they’re probably too late.
The basics of valuation
The fact is, you can’t wait until it’s time to sell to address the drivers of property valuation. Instead, you need to proactively and systematically optimize individual property and overall portfolio value at all times.
Start with the basics: location matters. So does overall architectural desirability and property condition. The first step in ongoing property and portfolio optimization is to make sound decisions in areas such as initial acquisition and ongoing maintenance. Maintenance is particularly critical, as you don’t want to create a reason for a valued tenant not to renew.
Another way to optimize valuation is to continuously evaluate how a property is being financed. We recommend constant communication with a sophisticated mortgage expert to conduct quarterly or semiannual reviews of property financing. Even minor improvements to a financing can significantly improve cash flow and value. The one caveat here is to be aware of potential covenants, such as a prepayment penalty, that might be triggered in a sale. If you’re proactively looking to sell, look carefully at financing terms or hold off on refinancing.
“Be sure your financing reflects your investment strategy for a given property,” says Robert Daneke, Delta Bank’s credit administrator. “If you have a long-term hold strategy, then you may be more open to restrictive loan covenants that can reduce financing costs. If you have a shorter horizon, then flexibility in financing may be a primary driver.”
David Quinonez, vice president with NAI Benchmark observes, “If an owner secures assumable long term financing at favorable rates, this can become a major selling point as interest rates rise in the future.”
Retain those tenants
Owners need to keep their buildings occupied. The loss of any tenant can lead to significant expenses including lost rental income, new tenant build-out allowances and brokerage commissions, to name just a few. In general, higher renewal rates translate into more secure cash flow and higher valuations. So one of the most important steps to optimizing the value of any CRE portfolio is to build and maintain a robust tenant retention program. Key components of such a program include:
- Identifying “most valuable” tenants
Some tenants are just more valuable than others. It could be their sheer size in relation to the rest of the portfolio – their failure to renew represents too great a risk to cash flow and value.
It could be that they are less cost sensitive than other potential renters or lessors – negotiating less hard to obtain the lowest all-in costs.
Or theirs could be a marquee name, aiding in attraction and retention of other retail or office building tenants. Regardless of the reasoning, CRE managers need to understand the relative value of their tenants and to allocate retention efforts and resources accordingly.
- Conducting ongoing relationship assessments
Property managers should conduct ongoing assessments of the state of all, but especially their most valuable, tenant relationships. Ongoing communication with key tenants should be a given. Of course, the more valuable the tenant, the more intimate the interaction.
Address issues proactively to prevent small issues from growing into larger concerns that could lead to non-renewal. Even in cases of many smaller tenants, property managers can use tools such as customer surveys to get a sense of conditions and what might be done to improve satisfaction and boost renewal rates.
- Renewing proactively
Be equally proactive in renewing leases and rental agreements. All too often, property managers wait until 180 or so days before the end of the contract term before seeking renewal. Instead, formal renewal efforts should begin at least 12 months if not two years for larger and/or most valuable tenants. The earlier the process begins, the more likely it is that the property manager can identify potential problems that can often be overcome in time to still secure a renewal.
“It is easy to be passive with tenant relationships – collect rent and assume everything is fine until a problem,” says Matt Kozina, director of asset and property management for NAI Benchmark. “Having an engaged, ongoing relationship with all the key decision makers for an important tenant takes time, effort, and diligence – but it pays off tenfold.”
Proactive, ongoing, disciplined
Indeed, it’s a seller’s market across most of the nation’s major CRE segments, and the Central Valley is no exception as investors in major markets look to increase yield in tertiary markets. To take full advantage of the market and investor demand for quality properties and achieve top valuations for your asset, it’s important to deploy an ongoing, proactive and disciplined approach. And the time to start is now.